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Neglected Ideas

Jonathan Clements

THE MOST POWERFUL financial ideas are those that help us make better money decisions—by providing a lens through which to understand ourselves and the world around us. Examples? Think about notions like loss aversion, diversification and market efficiency, all ideas frequently mentioned in HumbleDollar articles. Every investor, I believe, should understand such concepts.

To that list of key ideas, I’d favor adding five others—all underappreciated, I’d argue, but all central to how I think about the financial world.

1. Market portfolio. This is the worldwide universe of stocks, bonds and other investable assets, each weighted by its market value. It’s what all investors collectively own, and arguably it should be the starting point when deciding how to structure a portfolio.

My bond portfolio looks nothing like the global bond portfolio. Instead, it consists entirely of short-term U.S. government bonds, divvied up between conventional and inflation-indexed securities. This is the money I may end up spending over the next five years, so I figure I should minimize the potential damage from rising interest rates, a strengthening U.S. dollar or deteriorating credit quality.

But when it comes to stocks, I do indeed take my cues from the market portfolio. My stock investments don’t precisely resemble the global market. For instance, I’m overweighted in U.S. and international small-cap and value stocks, and also overweighted in emerging markets.

Still, the global market portfolio is my benchmark. In fact, a total world stock index fund is my largest single holding, and I always know precisely how I’m straying from the market portfolio. One way I don’t stray: My mix of U.S. and international stocks pretty much matches the global market, with roughly 50% allocated to each.

2. Intrinsic value. I can’t tell you with any certainty what the intrinsic value is for any individual stock or for the broad stock market, nor whether that value is above or below current share prices. Nobody can. But every stock does indeed have an intrinsic value—and that value changes far more slowly than each company’s stock price.

This is what gives me the confidence, whenever the broad market falls out of bed, to invest more in my stock index funds, which I did with gusto in 2008-09 and early 2020, and I’ve been doing with somewhat less gusto this year. On such occasions, I can’t be sure I’m getting a bargain. But I know the underlying businesses probably aren’t losing value as quickly as their share prices, so there’s a good chance that some panic selling is taking place—and thus I’ll potentially profit from the irrationality of others.

3. Consequences. Risk is perhaps the most important financial idea, and yet it’s one that’s often ignored. Two concepts, in particular, are worth keeping in mind. First, more things can happen than will happen. Second, we should consider not just the odds of a bad outcome, but also the consequences.

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In other words, we should be aware that the future could head off in all kinds of possible directions and we need to make sure our financial life won’t be too badly damaged, no matter what comes to pass. This means taking precautionary steps that, in retrospect, will likely appear unnecessary. We’re talking about things like diversifying broadly, buying insurance and holding a stash of emergency cash. Most of the time, such steps will slow our nest egg’s growth, and yet failing to follow such steps would be the height of financial foolishness.

4. Don’t be your results. I first read about this notion in an article by Don Southworth. Don was writing about his career in sales, and how he was advised not to let his recent sales record affect his mood.

The same notion can also be applied to money management. We shouldn’t let our state of mind be influenced by our portfolio’s short-term performance or the size of our net worth, and not just because this could lead to unhappiness. If we become our results, there’s a risk we’ll make bad financial decisions.

How can we counteract this? Try to keep three notions in mind. First, if we consistently do the right things—save diligently, minimize taxes, hold down investment costs, index, diversify globally—we should eventually get rewarded, even if our prudence doesn’t show up in our results right away. Second, just because something can be measured—such as our year-to-date investment performance or the size of our net worth relative to that of others—doesn’t mean we should focus on it. Third, if we pay too much attention to our financial results, we can become obsessed with accumulating ever more, rather than figuring out what constitutes enough.

5. Money and meaning. There’s what we think we want from our money—and then there’s what we truly want. It can take a lifetime to figure out the difference.

For all of us, money brings with it a raft of emotions—what we were told by our parents and corporate marketers, what we imagine others think, and what we learned from financial experiences, both good and bad. These influences and experiences both mold our personality and are also filtered through it. For instance, you might easily shrug off a big stock market decline, but that same decline could traumatize your friends, leaving them even more risk averse. Similarly, a spanking new BMW, which you view as the height of financial foolishness, might strike your neighbors as the sure road to happiness.

Somehow, we need to peel back these layers, figuring out how we can best use the dollars we have to make our life richer. How do we know we’re being successful? The goal is to get happiness from our money that far surpasses the nominal dollars involved. If the BMW brings you joy day in and day out for years on end, it’s money well-spent. But if you sit in your cubicle, wishing you’d instead put the dollars in your 401(k) so you can quit the workforce a few years earlier, you likely bought yourself a lemon.

Jonathan Clements is the founder and editor of HumbleDollar. Follow him on Twitter @ClementsMoney and on Facebook, and check out his earlier articles.

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Boomerst3
Boomerst3
15 days ago

I had my short term money in Vanguard short term and TIP ETFs, but moved them to cash because interest rates were going to go up big, relatively speaking. I was surprised they went down as much as they did, considering how short term they are. I’m happy with that move and the 1.5% the cash it is earning now. As interest rates stabilize, I’ll move it back to the bonds.

David Wacker
David Wacker
24 days ago

Jonathan, as I recall you split 50/50 between regular treasuries and inflation protected. Would you hold inflation protected in taxable acct if there isn’t space on tax advantaged side? Or would the split be forced to favor regular treasuries?

Jonathan Clements
Admin
Jonathan Clements
24 days ago
Reply to  David Wacker

I hold both in my IRA. But if I had to hold one in a taxable account, it would be the conventional short-term Treasurys. That way, you’d be receiving in cash everything that’s being taxed — whereas with TIPS you could have a situation where, because of inflation-driven increases in principal value, you receive less in cash during a given year than you owe to the taxman.

Nicholas Clements
Nicholas Clements
24 days ago

Jonathan, I also find myself less enthusiastic about buying into my stock funds at the moment. What is your reasoning?

Jonathan Clements
Admin
Jonathan Clements
24 days ago

Nick: See my comment below.

Philip Stein
Philip Stein
25 days ago

Jonathan, you invested additional dollars in your stock index funds with gusto during the 2008-09 and 2020 downturns, but “with somewhat less gusto” this year. Why the waning enthusiasm? Is it because you’re older now and, as Bill Bernstein has admonished us, you’ve won the game so why keep playing?

Jonathan Clements
Admin
Jonathan Clements
25 days ago
Reply to  Philip Stein

To state the obvious, stocks are down less this year than in 2020 or 2007-09. But equally important, I don’t sense the fear we saw during those two earlier declines — and it’s those moments of mass panic when markets become truly untethered from their intrinsic value and great bargains can be had. Most of the time, markets are highly efficient and, indeed, this year’s decline doesn’t seem wholly irrational, given high inflation and the possibility of a recession.

John Wood
John Wood
25 days ago

To your item #4 (“Don’t Be Your Results”), I’m reminded of Charlie Munger’s line “Life is more than being shrewd at passive wealth accumulation.”

A good reminder to go live life, and that money is just a tool for doing so.

patdady
patdady
25 days ago

My portfolio, not surprisingly after years of following you, looks much like yours. I too have about five years of my cash requirement in short term Vanguard funds. May I expect Vanguard will hold many of its current short term bonds to maturity, and, if so, ultimately recover the “paper losses” of the past few months?

Jonathan Clements
Admin
Jonathan Clements
25 days ago
Reply to  patdady

I don’t know whether the funds will hold their bonds to maturity. But the losses on shorter-term bond funds have been modest, so it won’t take long for investors to recoup those losses through regular income distributions.

jm wylie
jm wylie
25 days ago

I am 81 and I look at risk in a shorter time frame than maybe others. I have had some market success over the last 20 years and want to pass on to my grandkids what I have accumulated. So I have gotten out of emerging markets -VWO – and VTMGX Developed European markets – and reinvested in total stock market at lower prices. Just think it will take the rest of the world -especially Europe – much longer to recover from Russian oil and gas cut off than the US economy. I am betting on the US. That is my short term view.

Michael1
Michael1
25 days ago
Reply to  jm wylie

Hi Jim, your last sentence basically encapsulated my thought as I was reading your post. This is your short term view, but did you consider that your grandkids’ time horizon is much longer, and so maybe that global portfolio is even more appropriate for them?

Peter Blanchette
Peter Blanchette
25 days ago

Given that the greatest bond bull market in history is over, at least for the foreseeable future, are your ST bonds in the form of funds or individual bonds? I assume you are buying individual bonds.

Last edited 25 days ago by Peter Blanchette
Jonathan Clements
Admin
Jonathan Clements
25 days ago

No, I own a pair of low-cost Vanguard funds. I know many investors like the illusion of certainty that comes with holding individual bonds to maturity, but I prefer the convenience and easy reinvestment offered by funds, and the fact that I don’t know to the penny what my bonds will be worth in two years doesn’t bother me.

DrLefty
DrLefty
25 days ago

The comment about “doing the right things” reminds me of the books Atomic Habits and Tiny Habits, and I’ve seen the same logic applied to weight loss: If you eat at a calorie deficit and keep active, you might not see the results on the scale the first week or even the first month, but over time, those habits will pay off both in short-term goal of losing weight and in the more important longer-term goal of having sustainable, healthy habits to take you into old age.

HumbleGardener
HumbleGardener
25 days ago

Number four is interesting to observe in myself. Even though I know my portfolio construction, planning, and money habits should let me weather any storm, I still feel it when the wind begins to blow. On the flip side, my smile grows with my portfolio. My wife and I joke about it. I felt the tension much more in early 2020 than in 2008-9, probably because retirement was then a distant dream. With retirement close, I think about how a will react to financial fluctuations then. Still an area for personal growth.

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